We will be carefully watching as yesterday Finance Committee Chair Senator Baucus released a series of reforms designed to simplify and improve administration of the tax laws. Tax Prof has an excellent landing page, linking to the proposed statutory language, the press release, a well-done Joint Committee report summarizing the proposals (JCT Report), and some third party summaries of the proposals.
I will not review the proposals in-depth here, but I want to address the main categories of the proposals, make a few general observations, and note some specific provisions that have been the subject of previous discussion in our blog.read more...
The proposals are self-styled as a discussion draft, and while I have no particular insight into the state of the legislative process, it is unlikely that we will see substantive or procedural tax reform in the near term (Senator Baucus released a discussion draft on international tax reform proposals earlier in the week; I suspect that both proposals are not likely to be the subject of short-term legislation).
From the news release, Senator Baucus frames the proposals as having the following goals:
- Simplify the tax filing process and greater utilize technology;
- Provide the IRS with new tools to combat tax-related identity theft; and
- Reduce the tax gap by increasing information reporting
There are over 30 specific proposals, broken out into the following general categories in the JCT Report:
- Information return proposals relating to timing and format of filing
- Identity theft and anti-fraud proposals
- Targeted information return proposals meant to reduce opportunities for underreporting of income
- Expansion of E-filing requirements
- Audit and collection changes
- Tax return filing date changes
- Changes relating to taxpayer access to judicial review of certain IRS determinations; and
- Miscellaneous changes that do not neatly fit into the above
I will save for a later date a detailed explanation of the proposals, but I note that underlying many of the procedural changes is an emphasis on improving visibility and accountability as levers to nudge taxpayers and preparers alike to report accurately, especially on issues that are subject to stubbornly high error rates.
For example, the information reporting changes include a more specific disclosure requirement for Schedule C taxpayers. Tax gap data suggests that the bulk of underreporting of income is attributable to small business taxpayers understating income. The JCT Report at page 23 describes proposals attempt to smoke out improper small business underreporting:
The provision requires individual taxpayers engaged in a trade or business as a sole proprietor to separately state the aggregate amount of gross receipts or sales reported to the taxpayer through payee statements, and the number of payee statements received. The provision also requires the taxpayer to separately state the total amounts of expenses reported to the taxpayer through payee statements, the number of payee statements furnished by the taxpayer, and other information as the Secretary deems necessary.
Other provisions that stand out include giving IRS specific authority to regulate return preparers—effectively overruling the Loving case currently on appeal, and expanding the EITC preparer due diligence requirements to another refundable credit, the child tax credit. As I have previously written, I believe both regulating unlicensed preparers and expanding due diligence are keys to influencing preparer and taxpayer behavior. These proposals recognize that the IRS’s tool kit must go beyond “audit and penalize” as the main levers for reducing the tax gap.
Increasing a reliance on gatekeepers and enhancing third-party and taxpayer disclosure of selected items will increase the psychological costs associated with not reporting accurately. I believe that the decision to comply or not comply with your tax obligations goes beyond that associated with typical rational actor cost/benefit model that relies mainly on considering the benefit of cheating with the expected costs from not complying. My views about the inadequacy of the rational actor model for tax compliance are not novel. Dan Ariely, who is a Professor of Psychology and Behavioral Science at Duke, has written extensively about irrationality and has penned a fascinating book The Honest Truth About Dishonesty: How We Lie to Everyone-Especially Ourselves. In it, he examines what motivates people to lie. Its main achievement is to describe and synthesize views on how cheating and lying are most often driven by factors other than a simple direct cost benefit analysis that relies principally on severity of sanction and odds of detection. Instead, as Professor Ariely demonstrates through social science experiments and lessons from everyday life, people are animated by two competing influences. On the one hand, people “want to look at themselves in the mirror and feel good about themselves….on the other hand, [people] want to benefit from cheating and get as much money as possible.”
Ariely notes that that things like being forced to sign your name with an accuracy pledge at the top of a tax form or relying on gatekeepers who are sufficiently monitored can increase cheating’s psychological costs and drive down errors. The theory is not that everyone will respond to these softer influences—you cannot take the cops off the street—but structural changes and the bright lights of monitors and disclosure can indeed influence conduct.
Viewing many of the proposals through the prism that Ariely suggests helps place many of the proposals in context. That is important because many of the proposals, like return preparer regulation, enhanced due diligence rules and increased small business disclosure requirements, have immediate and direct costs. I do not want to minimize those costs, but focusing solely on the costs side of the equation is in my view inadequate.
The proposals include some more technical provisions, including a plan to address the venue ambiguity in CDP cases that guest blogger Carl Smith identified in discussing the Byers case. There is a lot more to digest and we will return to some of the proposals in greater depth. I note that the Senate is encouraging people to submit feedback on the tax administration discussion by January 17, 2014, with comment to be sent to: Tax_Reform@Finance.Senate.gov.